We leveraged Milton’s natural language processing ability and concluded that Federal Reserve policy is dominating financial headlines and is top of mind for investors in the wake of a rocky start for US stocks during Q4 2018. We’ll also touch on why this topic is so relevant today.
Background: Contextualizing the Market Sell-Off
October has been a tough month for stocks and 2018 is off to the worst start to a fourth quarter since 2008, as measured by the S&P 500's absolute return month-to-date. It is important to note the S&P 500 has had positive absolute returns during the fourth quarter in 25 of the past 30 years, dating back to 1988, with an average return above 5% during that same time frame. Financial academics and professional investors broadly acknowledge that historically, US stocks are bullish into the year-end. This favorable seasonality into year-end is often referred to as the "Santa Claus Rally" (or "December Effect") and was first documented by financial publications in the early 1970s.
Market Sell-Off: What is Happening?
It’s difficult to identify a single cause of short-term market fluctuations, but the AI technology powering Milton "ingests" almost every news article a human could read on a daily basis and uses that information to generate insights for users. In fact, Milton reads over 60,000 new text-based financial documents every week, including news, corporate filings, and management transcripts. Roughly the equivalent of 4,000 to 5,000 hours of human reading time (or 208 days of non-stop reading!). Studying what Milton reads every day, en masse, is one way our team can identify trends that are most relevant for investors and the financial markets.
According to Milton the key topics dominating financial headlines since the sell-off began are:
• Rising US interest rates
• Escalating trade tensions
• Chinese economic growth concerns
• Cooling US housing sector
• Geo-political tensions impacting energy prices
• Uncertainty about midterm elections
But What Is The Market's Biggest Concern?
Based on our analysis, we believe that the Federal Reserve (or the Fed), is dominating investor mindshare in the wake of the market sell-off of the past five weeks. So it is no coincidence that we put "Rising US interest rates" as the first bullet point above when highlighting the key topics dominating financial headlines in recent weeks. We define Volume as a topic’s relevance to financial media.
To determine the Volume, we took sample data from Milton and measured the frequency of keywords to identify topics covered by reputable financial news sources. To do this, we queried Milton's database (containing millions of articles) to compare the frequency of key terms from August 24th, 2018 to September 23rd, 2018 (31 days) and September 24th, 2018 to October 24th, 2018 (31 days). We selected them because the first date range was just prior to the Fed's September interest rate hike (see below for more detail on this). The results were clear when thinking about the increase in the "Volume" related to the Fed over the past one month.
When we compared those two ranges in Milton’s database, we learned the following:
• The term "Federal Reserve" grew +196% month-over-month with the number of articles with the term "Federal Reserve" growing +138% and the frequency of the term in each article rising.
• The term "Jerome Powell" (current Federal Reserve Chairman) grew +197% month-over-month with the number of articles with the term "Jerome Powell" growing +190% and frequency of the term in each article rising.
• The term "Rising Rates" grew +430% month-over-month with the number of articles with the term "Rising Rates" growing +389% and the frequency of the term in each article rising.
In each case, the total amount of times these terms appeared in absolute terms increased, the number of articles containing the term increased, and the frequency of the term within each article increased. Based on these metrics, the identified topics were substantially more relevant to the financial media and investors month-over-month.
But how does this compare to other key topics impacting financial news today such as the prospect of US tariffs on imported products or potentially slowing Chinese economic growth. Our team conducted the same exercise across other keywords during the same two timeframes and learned:
• The term "Tariffs" declined -26% month-over-month with the number of articles with the term "Tariffs" declining -30% and the frequency of the term in each article rising modestly.
• The term "China" grew +2% month-over-month with the number of articles with the term "China" declining -4% and the frequency of the term in each article declining modestly.
• The term "Housing" grew 21% month-over-month with the number of articles with the term "Housing" growing 20% and the frequency of the term in each article staying roughly flat.
In contrast to keywords related to the Fed, which increased dramatically, these other keywords have only upticked slightly. In addition, in almost every instance, the keyword frequency per article was flat to declining versus rising dramatically in the Fed examples mentioned earlier. While this may not seem like the most scientific approach to analyzing the "root cause" of changes in market sentiment, we have found that this approach historically works well when analyzing changes in historical market regimes and company-specific sentiment.
Now that we’ve identified a likely cause of souring investor sentiment, let's quickly review why people are talking about the Fed so much!
So Why Is The Federal Reserve In Focus?
The Fed finds itself in an increasingly unenviable position, with President Trump escalating attacks against the newly appointed Fed Chairman Jerome Powell in recent weeks, while cooling data in the US housing and auto sectors have some market participants suspecting that a further rise in interest rates could trigger a slowdown in the US economy.
The Federal Reserve is an independent institution and among its most notable mandates is to set the Federal Funds Rate during one of eight annual FOMC meetings ("Federal Open Market Committee" meetings). These rates help guide US interest rates. Since 2015, the Fed has raised interest rates on eight occasions, with the most recent interest rate hike on September 26, 2018, setting the Fed Funds Rate at 2.25%. During that meeting, the Fed indicated one additional hike in December 2018 to 2.50%, a target of 3.00% in 2019, and a target of 3.50% in 2020.
To contextualize the rise in interest rates, we aggregated some of the data Milton ingests from public sources for you to visualize the Fed Funds Rate since 2014 versus the year-over-year change in the Fed Funds rate including projections from today through 2020 based on the forward guidance from the September 26, 2018 FOMC meeting regarding future interest rate hikes.
In the chart above, the blue line corresponds to the left axis and represents the effective monthly Fed Funds rate since 2004 in absolute percentage terms. The red line is the year-over-year change in the effective Fed Funds rate - as you can see, this number went negative during the financial crisis since the Fed was aggressively lowering interest rates and only started to modestly go positive in 2015. The red box in the top right of the screen is where we are today (as of Q4 2018).
Why is it interesting? While the Fed Funds rate continues to rise through 2020, the steepest part of the journey uphill is over the next few months, as measured by the year-over-year increase in the effective Fed Funds rate. Many of the key financial indicators we depend on to gauge the health of the economy rely on an understanding of year-over-year metrics. to measuring the health of key sectors such as housing and auto, that largely depend on financing to sustain growth.
At a time when interest rates are rising, albeit modestly, understanding that we are in the steepest part of the hiking cycle when evaluating year-over-year changes is important for evaluating companies and sectors that rely on financing to sustain growth.
If you have any questions or comments about our findings or Milton in general, feel free to reach out directly to the Milton team at email@example.com or myself at firstname.lastname@example.org!
Apteo, the company behind Milton, is made up of curious data scientists, engineers, and financial analysts based in the Flatiron neighborhood in New York City. We have a passion for technology and investing, and we strongly believe that investing is one of the most reliable and effective ways to build long-term wealth. We build AI tools to help informed investors make better decisions.
Apteo, Inc. is not an investment advisor and makes no representation or recommendation regarding investment in any fund or investment vehicle.
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